The Real Cost of the Bailout

The battle is on!

Friday, the Dow jumped up 217 points. Oil held steady at $40. Gold didn’t move either; it remains at $914.

But let’s take a quick look at the combatants…and try to understand what is really going on.

On the one side is General Market. He’s a sly, unpredictable…some would say ‘unbeatable’…foe. He’s also extremely aggressive.

On the other side, there are the feds…the fixers…the meddlers…the central bankers and finance ministers. They have their ground troops, their weapons of mass destruction, their defensive ramparts, and their strategic theories. And many people believe they have the ultimate weapon in this war – the Nuclear Option…

For the last year and a half, General Market has been master of the field. He’s rolled back the fixers everywhere. The world’s stock markets have suffered defeat after defeat – wiping out about half their wealth, about $30 trillion worth. Even markets thought to be “decoupled” with those of the Western world – such as China and India – fell right over as soon as General Market attacked.

As to property…General Market has already captured about 25% of the domestic real estate in the United States…and who knows how much overseas.

In some places, U.S. housing has suffered more damage than from a fire or a tornado. In Lehigh Acres, near Fort Myers, Florida, the New York Times says houses are selling 80% off their peaks. “Fast food restaurants are laying people off or closing. Crime is up, school enrollment is down and one in four residents received food stamps in December, nearly a fourfold increase since 2006.”

It’s back to the ’30s in Lee County, Florida:

“The organizations offering food in Lehigh Acres have seen demand increase by as much as 75% in the last year. And the people being served are no longer just the chronic poor. The line at Faith Lutheran had a mix of ages, races, and former income levels.”

Abandoned houses are stripped of anything that can be sold…and used by drug gangs.

And it’s not just housing that is being abandoned. “Ghost malls,” are coming soon, says one commentator. People without money don’t buy stuff. And so, malls are where they don’t go. Malls become abandoned…deserted…vandalized, taken over by gangs and crazy people.

Hasn’t happened yet? Stay tuned…

General Market has done to world property values about what Sherman did to Atlanta. Nobody knows the total loss, but it is probably near $15 trillion…

And there are huge losses in other areas too. Corporate bond prices – especially in the ‘junk’ category – have collapsed. Hedge funds, banks and investment firms have lost billions in speculations. The value of minerals and oil have fallen 50% – 75%.

What’s the total damage? Rupert Murdoch says it’s around $50 trillion – which is probably not too far off the market.

But the feds aren’t completely beaten. They’re mobilizing all over the world to fight the depression. Yes, the ‘d’ word has escaped the censors. Bill Gross of PIMCO says the US could be headed for a ‘mini-depression.’ And over at MSN Money, Jon Markman wonders if it isn’t already “too late to escape a depression?”

We keep pointing out that you can fight a recession with rate cuts and more public spending, but you can’t beat a depression using those tactics.

Still, the feds are going to try! Today’s news tells us that they’re becoming more and more desperate.

“Obama rolls out his big guns,” says the headline in the International Herald Tribune. The big guns are blasting away in favor of the administration’s Boondogglization program:

Larry Summers told Congress to pass Obama’s stimulus bill “as quickly as possible, to contain what is a very damaging and potentially deflationary spiral.”

Obama himself said we might be on the verge of “catastrophe.” And Summers added, “If there was ever a moment to transcend politics, this is that moment.”

But what good is $1 trillion worth of boondoggle spending going to do? General Market has just erased $50 trillion assets. All together, the feds have probably been able to put back a couple trillion – at most. And most of what they are putting back is just taken from some other front…it is not really a net increase in the feds’ firepower.

*** There are two main schools of thought on the bailouts.

1) they are not targeted properly (the media spends a lot of ink debating whether the bailouts should be loans, asset purchases, direct takeovers, bad banks or other gimcrackery)

2) they are not big enough…(which we will discuss in a minute)

And then, there’s our hooky school of thought too. If there is evidence or experience to suggest that these bailout plans will work we haven’t heard of it. In the two instances in which they were tried, they failed. Plus, there is no theory that makes any sense to us explaining why or how they SHOULD work. Bad bets don’t get better when you lend the bettor more money. They just become more expensive.

But no one is interested in our analysis or our advice. We keep our “President’s Hotline” available. Obama can call anytime he wants. We’ll even pay for the call. But no government has ever asked our counsel; probably, none ever will.

So, let’s return to the advice that the feds are taking seriously:

The U.S. risks “falling into an economic abyss,” says Nobel-prize winning economist Paul Krugman. He says we’re “on the edge of catastrophe.”

Hold on a minute. Krugman’s warning bell sounds for all the world like the one we used to ring regularly. We used words like “abyss”… “catastrophe”…. “disaster”… “Armageddon.”. We needed to yell like that to get readers’ attention. Most ignored us anyway; they thought we were kooky alarmists. Besides, they were sure everything was great and getting better all the time.

Now, we no longer have to use words like ‘apocalypse’ and ‘armageddon.” Thank God. Words like that are hard to spell. Besides the facts shout loudly enough. We don’t need to get anyone’s attention. What’s needed now is quiet reflection.

Krugman is screaming because he thinks the U.S. bailout plan is not bold enough. He’s right about that. You’re not going to offset General Market’s $50 trillion in damages to with $1 trillion in boodoggles. Krugman thinks you need to spend a lot more.

The aforementioned Bill Gross of PIMCO agrees. He says “trillions” will have to be spent.

And so, dear reader, the war goes on.

And it’s getting more and more expensive. General Market does his damage. And the cost of fighting him mounts. Goldman Sachs says the U.S. Treasury will borrow $2.5 trillion this fiscal year.

How are they going to borrow that kind of money without driving up the price of borrowed funds? ‘Borrow from yourself,’ say the simpleton advisors. They’re urging the Fed to buy the Treasury’s paper itself. That way, America won’t be beholden to foreign lenders – notably, the Chinese – and bond yields won’t be forced up by the buying pressure.

But wait a li’l cotton pickin’ minute. Where does the Fed get trillions of dollars to buy U.S. paper? Oh, we forgot…it just creates it ‘out of thin air.’

Two and a half trillion is nothing but a little ‘2’ and a little ‘5’ followed by 11 little zeros. Heck, the Fed has all the zeros you could want. If not, it can always borrow some from Gideon Gono. He just took 12 zeros off the Zimbabwe dollar; maybe we’ll be able to use them in the US.

More tomorrow…on the feds’ counterattack…the lack of pricing power…and the Nuclear Option…

*** We were out in Normandy over the weekend. It snowed all day Saturday. But we made a fire in the fireplace and enjoyed a quiet evening.

On Sunday, a reporter from the New York Times came to lunch.

“I’m doing a piece on Americans who have bought these great houses in France,” she explained. “I’d like to tell your story to our readers.”

“It’s a sad tale,” we began. “A tale of woe, hardship, and stupidity worthy of a banker…

“The word ‘chateau,’ as perhaps you know, means ‘money pit’ in English. You throw your money into the pit, and the local people and the tax collectors come and dig it out. You start out in good shape…with a broken down chateau. You end up with a chateau in good shape; and you’re broken down. But it’s okay. The balance of the world’s money system is maintained. Money is redistributed from weak hands to stronger ones…it’s all a part of the big picture.”

“Why didn’t you just sell the place?” she asked.

“Oh…it doesn’t really work that way. The world of money, I mean. People don’t do things because they make them richer. Money has to circulate. If you don’t have it, you need to get it. If you have it, you need to get rid of it. That’s just the way things work. Of course, you don’t WANT to get rid of it. At least… not consciously. But you always have some weakness…some feeble place in the dike that protects your New Orleans. And sooner or later – sooner, most likely – the gods find your weak spot. And that is where the flooding begins.

“You see, we made a little money in the boom, like everyone else. But as a gloom and doom economist, we couldn’t lose it like everyone else in the bust. We knew stocks were going down. And even oil…we knew it was a bubble. So, we couldn’t hold stocks in Lehman Bros. We couldn’t invest in derivatives. We knew Madoff was up to something…we didn’t know what, of course.

“Since we spent so much time thinking about how dangerous and absurd the financial markets were, we couldn’t just sit with our money fully invested on Wall Street. We would have felt like fools. We had to find some more original way to part with it.

“All the easy avenues to losing money were blocked off to us. Any reasonable person would have dumped this place long ago. It’s cold. It’s hard work. It’s one problem after another. But we needed it. We come out here every weekend we can…we cut trees…we paint windows…we fix walls and repair plumbing. And every day, we get poorer. You see, the chateau plays a valuable role. We have a weakness for old stones…old buildings…and old liquor. The gods discovered it…and put this place in front of us…like a bottle of Jim Beam in front of a dipsomaniac. You can’t argue with the gods. Besides, you’ve got to keep the great cycle of money turning. We don’t keep at it for ourselves, in other words, but for the good of the human race.

“Do you see? ”

“Uh…I guess so…”

Until tomorrow,

Bill Bonner
The Daily Reckoning